Knight Survives Another Day With Short-Term Financing

Knight Capital Group Inc.'s $440 million loss compares with net income of $115.2 million in 2011 and is more than the company’s market value of $253 million at the close yesterday, data compiled by Bloomberg show. Photographer: Jin Lee/Bloomberg

Aug. 4 (Bloomberg) -- Knight Capital Group Inc., fighting
to stay afloat after a $440 million loss spurred by a software
bug, scrambled with its advisers to find a buyer or investor.

The market maker responsible for about 10 percent of
American equity volume turned to Goldman Sachs Group Inc. on
Aug. 1 to buy the firm out of trading positions acquired by
mistake when a computer program malfunctioned, a person with
knowledge of the matter said. It has until the close of business
on Aug. 6 to complete the transaction.

“There’s a lot of questions about their liquidity -- do
they have the money to get through the trade settlement on
Monday?” Patrick O’Shaughnessy, an analyst at Raymond James &
Associates Inc., said in an interview with Pimm Fox on Bloomberg
Television’s “Taking Stock.” “They have to find somebody to
either invest capital into the company or somebody who’s just
going to buy the company outright.”

Knight made it to the weekend after receiving short-term
financing for market making, according to a person familiar with
the matter who requested anonymity. TD Ameritrade Holding Corp.
and Scottrade Inc., which sent trades elsewhere for execution
after Knight’s software bug, said they were routing orders back.
Knight’s stock surged 57 percent to $4.05 in New York after
tumbling 75 percent in the previous two sessions.

Private Equity

As the company opened its books to potential saviors,
people with knowledge of the matter said KKR & Co., TPG Capital
and Silver Lake were among buyout firms that had an initial
interest -- although one said chances of a private-equity deal
are small. Citadel LLC, the Chicago-based hedge fund, expressed
interest, as has Two Sigma Securities LLC, a New York-based
market maker, people with direct knowledge of the matter said.

“I seriously doubt they will go out of business,” Kenneth
Pasternak, who co-founded Knight in 1995, said in a phone
interview from his Ridgefield Park, New Jersey, private equity
firm Kabr Real Estate Investment. “I just hope they can
maintain the innovation. My fear is they will be bought by some
big bank and become consumed.”

Kara Fitzsimmons, a Knight spokeswoman, didn’t return calls
and e-mails requesting comment Aug. 3. David Wells, a spokesman
for New York-based Goldman Sachs, said he couldn’t comment.
Representatives at Silver Lake, TPG, KKR, Citadel and Two Sigma
declined to comment.

Adviser Aid

Knight is working with Sandler O’Neill & Partners LP as
advisers in the rescue talks, said one of the people, who spoke
on condition of anonymity because the discussions are private.

The trading fault, which caused stocks to move as much as
151 percent, left the firm with a “large error position,”
Knight Chief Executive Officer Thomas Joyce told Bloomberg
Television Aug. 2.

“We’re talking to a lot of capable people, people who are
in touch with situations like this,” Joyce said. “This was an
anomaly, not one we’re proud of.”

“After considerable review and discussion, we are resuming
our order routing relationship with Knight,” said Fred Tomczyk,
president and chief executive officer at TD Ameritrade, in a
statement. “Knight is one of many order routing destinations
for us and has long been a good and trusted partner.”

John Woerth, of Vanguard Group Inc., said in an e-mail that
the company continued to avoid routing brokerage orders through
Knight. Fidelity Investments, the second-largest mutual-fund
company, is sending orders elsewhere, according to a person
familiar with the matter, who asked not to be identified because
the information is private.

‘Biggest Risk’

“Knight may or may not have the ability to withstand this
on a balance sheet basis, but their biggest risk is if people
decide not to do business with them,” Keith Wirtz, who oversees
$14.7 billion as chief investment officer for Fifth Third Asset
Management in Cincinnati, said in a telephone interview. Fifth
Third is a client of Knight’s. “Your confidence with a
counterparty like a Knight is only as strong as their skills as
well as their balance sheet.”

About 23 percent of Vanguard’s market orders in NYSE-listed
securities were routed to Knight last quarter, according to a
filing. The figure was 41 percent at Scottrade, 38 percent at
Fidelity’s National Financial Services LLC unit and 9 percent at
TD Ameritrade.

‘Break Down’

Fitch Ratings said in a statement that it does not expect
any major counterparties of Knight to suffer large losses even
in a bankruptcy scenario since many have already switched to
other market makers. The issue still may lead to a structural
change in the business, the ratings firm said.

“The events of the last two days again pose risks for
equity trading volume as many investors become more concerned
about seemingly unforeseeable risks related to trading
technology problems and the broader market impact of high-frequency trading systems that periodically break down,” Fitch
said in the statement.

The number of exchange-listed securities changing hands on
average each day fell 11 percent to 6.12 billion in July from a
year ago, according to data compiled by Bloomberg.

Peak Valuation

Knight’s $440 million loss compares with net income of
$115.2 million in 2011 and is more than the company’s market
value as of Aug. 3, data compiled by Bloomberg show. The company
was worth as much as $4.8 billion in 2000 and valued at more
than $1 billion before the trading mistakes, according to data
compiled by Bloomberg.

The loss represents about 40 percent of Knight’s book value
and would “exhaust” the firm’s cash, according to CLSA Credit
Agricole Securities. Knight had $365 million of cash as of the
end of June, with about $70 million in its revolving credit
line, Robert Rutschow, a New York-based analyst with CLSA, wrote
in a report.

Knight’s market-making unit executed a daily average of
$19.5 billion worth of equities in June, according to its
website. The unit traded 711 million exchange-listed shares a
day in June, according to data compiled by the company and
Bloomberg.

The NYSE reviewed trading in 140 stocks from Molycorp Inc.
to AT&T Inc. as the market’s Aug. 1 open was disrupted. Trades
that occurred during the height of the volatility were canceled
in six securities, where prices swung at least 30 percent in the
first 45 minutes. Trades in all of the other stocks were allowed
to stand.

Regulations Coming

The software malfunction was the latest black eye for the
computer infrastructure of an equity market still haunted by the
May 2010 market crash, the botched initial public offering of
Facebook Inc. and failed IPO of Bats Global Markets Inc.

George Smaragdis, spokesman for the Financial Industry
Regulatory Authority, said Finra has examiners at Knight and is
working with the firm and other regulators to review the impact
of the incident.

Securities and Exchange Commission Chairman Mary Schapiro,
whose agency is the main market overseer in Washington,
described the Knight event as “unacceptable,” and promised to
issue regulations to help prevent similar mishaps.

“I have asked the staff to accelerate ongoing efforts to
propose a rule to require exchanges and other market centers to
have specific programs in place to ensure the capacity and
integrity of their systems,” she said in a statement. The
chairman also said the agency will hold a public meeting with
industry participants in the coming weeks “to discuss further
steps that can be taken to address these critical issues.”

‘Inexorable Fragmentation’

The error highlighted the fragility of an industry spread
across about 50 trading venues. The head of the New York Stock
Exchange said the firm’s crisis is a “call to action” to fix a
market that’s grown too complex to explain to regulators.

“The structure that has evolved over the last decade in
the U.S. has led to inexorable fragmentation, really an emphasis
on speed, a feeling that if something is faster then by
definition it’s better,” NYSE Euronext Chief Executive Officer
Duncan Niederauer said during a conference call after the
company reported earnings Aug. 3. “We are understanding that
speed is not always better.”